Emerging markets expert Bart van der Made assesses the fallout of the latest chapter from the Argentinian holdouts dispute. Here the Neuberger Berman manager outlines the negative implications of the ruling.
The US Supreme Court’s rejection of Argentina’s “pari passu” appeal in litigation with creditors who had rejected past settlements on defaulted debt was, in our view, the worst possible scenario for the country’s finances.
The ruling confirms an appellate court decision that Argentina must make a $1.4 billion simultaneous payment to such holdout creditors the next time it pays “exchange” bondholders who had accepted substitute debt issues.
It also goes against market expectations that the court would first seek an opinion from the Solicitor General, which would have delayed the ruling until 2015.
That would have provided more flexibility to the Argentine government in negotiating with the holdouts, given the pending expiration of a key provision in bondholder agreements at the end of the year - which requires that holdouts not be offered better terms than the bondholders who accepted exchanges for bad debt in 2005 and 2010.
Mulling a swap
The Argentine government now has until July 30 to act. For now, the government’s preferred action is to try to swap the bonds subject to the court decision (governed by New York State law) for debt that is covered by Argentine law.
However, this strategy is fraught with risk as it could potentially violate anti-evasion orders in the lower court ruling, while the “pari passu” injunction would make it difficult for US-based entities to participate as investors or intermediaries.
In our view, this will ultimately push Argentina to deal with the holdout creditors. We see a cash settlement as unlikely, as it would likely trigger similar claims of up to $15 billion, which we don’t see as manageable given the country’s central bank reserves of only $22 billion.
A more probable scenario, in our view, is a negotiated bond settlement with the holdouts - especially since Argentine President Cristina Kirchner has reaffirmed the government’s commitment to honoring its external debt payments.
Manageable debt levels
While the ruling is negative, it’s important to keep things in perspective. Although debt levels could rise, we don’t expect Argentina’s public debt to rise beyond 60% of GDP, even in a scenario where the full $15 billion disputed amount is settled with new bonds.
This distinguishes the current situation from a traditional debt crisis in which high levels of indebtedness, rather than legal issues, have led to the inability to service debt.
In fact, Argentina has exhibited what we consider better policymaking in recent months by allowing more currency flexibility and reaching financial settlements with the Paris Club of creditor nations and Repsol, the Spanish oil company, which improved investor confidence and strengthened the country’s ability to avoid drawdowns in reserves.
In our opinion, the policy environment should improve further following the October 2015 election, when there will be a change in government.
Investment implications
Though a technical default would lead to further deterioration in market sentiment in the near term, for the medium term we see a good probability of an eventual investor-friendly outcome due to the manageable debt levels, the Argentine government’s willingness to service the restructured debt and the upcoming change of guard in the government around year-end 2015.
While the bonds governed by New York law (and the court ruling) have declined by around 11% since the announcement, we see current valuations as pricing in the expectation that some negotiations will follow.
We would look to avoid directional trades in these bonds due to binary risks surrounding what looks to be a tense and volatile series of talks.
At current prices, we think the BONAR and BODEN local law bonds (governed by Argentine law but traded in U.S. dollars, and not subject to the ruling) which have sold off in sympathy on the news but will not be subject to a potential technical default and can continue to pay coupons, offer an attractive risk-return profile.
With the weight of Argentinian bonds at a mere 1.7% of the EMBI Global Diversified Index, the most widely used hard currency benchmark, we see risks stemming from the episode as very low for global bond markets.
Contagion through trade and financial links to other emerging markets should also be limited as the country is not going through an insolvency crisis.